In the world of finance journalism, private credit is the new hot-button topic. It can be tricky, then, to reconcile the amount of private credit stories with the fact that levered lending – that is the sub-investment grade piece of the private credit market – is less than 12% the size of the US mortgage market, even after an astonishing decade of growth.
Given that pace of growth, it’s understandable that private credit has come under the media spotlight. A beat that only a few years ago was covered by around five specialist reporters now attracts closer to a hundred. The calls for greater transparency, a tighter focus shaped by stricter underwriting standards, and improved industry conduct are all valuable developments.
But in the rush to make sense of a new and emerging asset class, we must not lose sight of the bigger picture. This is a small part of a large market, and in some cases, the private credit discussion has carried a sense of alarm that isn’t necessarily warranted.
If left unchecked, this could deter portfolio managers for whom the class is viable.
A market under the microscope
Global private markets have grown rapidly in recent years, from less than $4 trillion in global assets under management (AUM) in 2008 to around $16 trillion today. In the UK alone, that figure is at approximately $185 billion.
As managers raised substantial AUM at speed, they faced pressure to deploy that capital into a market that wasn’t as large as many assumed. What is playing out now is the consequence of those dynamics, and it is right that investors are paying attention.
In part, this mounting scrutiny is due to the unusual visibility that US-listed Business Development Companies provide into an otherwise opaque asset class, enabling a level of analysis that is simply not possible in comparable markets such as private equity. The risk is that this window, combined with the increase in media coverage, has encouraged a level of scrutiny which recently has become hysterical.
Understanding the liquidity profile
Discussion around private credit has only intensified as calls have grown for its use in pension portfolios. The case for this is sound, but it is also fair to say the experience for investors has not always matched expectations.
Where the industry has perhaps disappointed participants is in the areas of extended deployment timelines, the watering down of underwriting standards, and slower return of capital, particularly in the tail of credit portfolios when outcomes are less favourable than expected.
In closed-ended funds there is no early redemption mechanism. Institutional evergreen products may offer some liquidity provisions, but these are typically tied to actual portfolio cash flows rather than an enhanced facility that allows exit within under a year.
Valuation discipline sits alongside liquidity as an area where scrutiny is warranted. A high share of portfolio assets marked at or near par is sometimes cited as cause for concern, but this largely reflects how these instruments work. They are predominantly floating rate and pre-payable, so par is exactly where most performing direct loans should sit. The more meaningful question is whether managers are marking assets down appropriately when conditions deteriorate.
If the broadly syndicated loan market sells off by 5%, a direct lending portfolio, with its greater seniority and tighter covenant protections, should likely be marked down of the order of 2% to 3%. Where marks do not move at all, investors should probe the methodology, the frequency of testing, and the independence of that process. These questions belong at the heart of manager due diligence.
Redefining the approach to private credit
Ultimately, the term “private credit” encompasses a far broader universe than most pension investors realise. Corporate direct lending, the strategy most commonly associated with the label, represents less than half of the broader private credit market. Specialty finance, consumer lending, mortgages and other asset-backed strategies all fall within the space, and many of these sub-sectors offer valuable diversification both from each other and from public credit markets.
An allocation built around a single strategy, or a single manager, is always going to carry risks that are not always visible until conditions change. Despite its growth and rapid institutional adoption, we don’t believe that private credit warrants systemic concerns, and well-founded interest in its conduct and standards shouldn’t be mistaken for a verdict on the asset class itself.
For pension funds prepared to approach it carefully, with a clear understanding of liquidity, a genuinely diversified construction, and rigorous manager selection, private credit remains a worthy part of the portfolio.
